Surprise from Fed: No pullback in bond purchases

WASHINGTON (AP) — The Federal Reserve isn't yet convinced that the U.S. economy is healthy enough for the Fed to ease its stimulus even slightly.

The Fed's cautious message Wednesday surprised — and pleased — investors, who had expected a slight cut in the Fed's $85 billion in monthly bond purchases. Wall Street celebrated the prospect of continued low interest rates by sending stocks surging to a record high.

In a statement after a policy meeting, the Fed said it has no set timetable for reducing its stimulus. It all depends how the economy fares.

Chairman Ben Bernanke explained later at a news conference that there are good reasons for the Fed to be cautious about slowing a bond-purchase program that's designed to keep long-term rates ultra-low:

— The Fed has yet to see conclusive evidence that the job market and economy are approaching full health.

— Rates on mortgages have surged, and the Fed's bond purchases are needed to hold those rates down and keep home buying affordable for ordinary people.

— A budget stalemate in Congress and the threat of a government shutdown as soon as next month are holding back growth and putting the economy at risk.

"Conditions in the job market today are still far from what all of us would like to see," Bernanke said at his news conference.

Stocks spiked immediately after the Fed released its statement at the end of its two-day policy meeting and closed at a record high. The Dow Jones industrial average jumped 147 points or 1 percent.

The Fed's decision to maintain the pace of its purchases raised hopes for lower rates on bonds and consumer and business loans. Bond yields sank. The yield on the 10-year Treasury note fell to 2.71 percent from 2.85 percent, the biggest one-day drop in nearly two years.

Since May, when Bernanke first signaled that the Fed could reduce its bond purchases this year, average rates on long-term fixed mortgages have surged more than a full percentage point to near two-year highs. The average on the 30-year mortgage is at 4.57 percent, according to Freddie Mac.

There are signs that higher mortgage rates have made it harder for people to afford homes The rebound in the housing market has been a key pillar for the economy.

The Fed lowered its economic growth forecasts for this year and next year slightly. It predicts that the economy will grow just 2 percent to 2.3 percent this year, down from its forecast in June of 2.3 percent to 2.6 percent growth.

Next year's economic growth will be a barely healthy 3 percent, the Fed predicts.

The Fed's policymakers expect the unemployment rate to fall to between 7.1 percent and 7.3 percent by the end of 2013, slightly below its June forecast of 7.2 percent to 7.3 percent. It predicts that unemployment will fall as low as 6.4 percent next year, down from 6.5 percent in its June forecast.

In its statement, the Fed noted that rising mortgage rates and government spending cuts are restraining growth. It repeated its plan to keep its key short-term rate near zero at least until unemployment falls to 6.5 percent from the current 7.3 percent. The Fed's short-term rate indirectly affects many consumer and business loans.

"We're in a slow-growth economy with high unemployment and low inflation," said Greg McBride, senior financial analyst at Bankrate.com. "There's no specific catalyst for the Fed to remove stimulus."

David Robin, an interest rate strategist at Newedge LLC, said Fed policymakers were surprised by how fast rates rose after they raised the possibility of scaling back the bond purchases. They likely worried that rates would rise even more, and jeopardize the economy, if they reduced the bond-buying.

Bernanke said the Fed is concerned that looming fights between Congress and the White House over the budget and taxes could slow the economy. Unless Congress can agree to fund the government past Oct. 1, a government shutdown will occur.

The government is also expected to reach its borrowing limit next month. Unless Congress agrees to raise the limit, the government won't be able to pay all its bills.

"This is one of the risks we are looking at," Bernanke said.

The Fed's policy statement was approved on a 9-1 vote. Esther George, president of the Federal Reserve Bank of Kansas City, dissented for the sixth time this year. She repeated her concerns that the bond purchases could fuel high inflation and financial instability.

The decision to maintain its stimulus follows reports of sluggish economic growth. Employers slowed hiring this summer, and consumers spent more cautiously.

Super-low rates are credited with helping fuel a housing comeback, support economic growth, drive stocks to record highs and restore the wealth of many Americans.

John Canally, investment strategist at LPL Financial, suggested that financial markets had overreacted in anticipation of reduced bond purchases.

Higher rates "started to impact the real economy, and (the Fed) got a little bit concerned."

Economists suggested that the Fed will still eventually scale back its bond buying, perhaps before year's end.

"Tapering will come sooner rather than later, assuming that the economy cooperates," Sung Won Sohn, an economist at California State University Channel Islands, wrote in a research report. "The economy is steady, though not strong, and is moving in the right direction

The unemployment rate is now 7.3 percent, the lowest since 2008. Yet the rate has dropped in large part because many people have stopped looking for work and are no longer counted as unemployed — not because hiring has accelerated. Inflation is running below the Fed's 2 percent target.

The Fed meeting took place at a time of uncertainty about who will succeed Bernanke when his term ends in January. On Sunday, Lawrence Summers, who was considered the leading candidate, withdrew from consideration.

Summers' withdrawal followed growing resistance from critics. His exit has opened the door for his chief rival, Janet Yellen, the Fed's vice chair. If chosen by President Barack Obama and confirmed by the Senate, Yellen would become the first woman to lead the Fed.